Bank Consolidation

and Merger Activity

Following the Crisis
By Michal Kowalik, Troy Davig, Charles S. Morris, and Kristen Regehr

T
he number of U.S. banks has trended lower over the past 30
years, dropping from about 14,500 in the mid-1980s to 5,600
today. The number of banks declined for many reasons, such
as failures during periods of crisis, consolidation spurred by the relax-
ation of state branching and national interstate banking restrictions,
and voluntary mergers between unaffiliated banks. Since the end of the
2007-09 recession, voluntary mergers have been the primary reason for
the decline.
Banks merge for a number of business-related reasons. Mergers
allow banks to achieve economies of scale, enhance revenues and cut
costs through operational efficiencies, and diversify by expanding busi-
ness lines or geographic reach. Bank mergers can result in more efficient
banks and a sounder banking system and thus benefit the economy, as
long as banking markets remain competitive and communities’ access
to banking services and credit is not diminished.
This article analyzes the financial characteristics of banks with as-
sets of $1 billion or less that were acquired by an unaffiliated bank in a
voluntary merger from 2011 to 2014. The analysis finds these mergers
are consistent with the goals of greater economies of scale and improved

Michal Kowalik is a financial economist at the Federal Reserve Bank of Boston. Troy
Davig is senior vice president and director of research, Charles S. Morris is a vice
president and economist, and Kristen Regehr is an assistant economist at the Federal
Reserve Bank of Kansas City. This article is on the bank’s website at www.Kansas
CityFed.org.
31
32 FEDERAL RESERVE BANK OF KANSAS CITY

efficiency. Acquired banks are generally smaller, less profitable, less ef-
ficient, and in weaker condition than their non-acquired peers. Section
I reviews the reasons for bank mergers. Section II describes the data.
Section III provides a qualitative assessment of acquired-bank charac-
teristics. Section IV analyzes the mergers to determine the relative im-
portance and significance of an acquired bank’s characteristics.

I. Reasons for Bank Mergers

Bank mergers drove the long-term downward trend in the number
of banks since 1985. Even in the crisis periods of the late 1980s, early
1990s, and 2007-09, the number of mergers exceeded the number of
failures every year.1 Chart 1 shows the number of community banks,
defined as banks with assets of $1 billion or less, along with mergers
and failures from 2007-14. Community banks are the focus because
mergers involving larger banks, particularly banks with assets of more
than $10 billion, are rare. For example, about 90 percent of the 1,500
mergers since 2007 involved a bank with less than $1 billion in assets.2
As Chart 1 shows, the number of community banks fell by al-
most 1,700, or 25 percent, from 2009-11. Although the crisis started
in 2007, the effects of the crisis and recession did not work their way
through the banking system for a couple of years. As a result, mergers
fell and failures rose significantly in 2009, though failures never ex-
ceeded mergers. Since 2011, the decline in the number of community
banks has been mostly due to voluntary mergers between banks.
Business-related reasons to merge reflect perceived opportunities to
increase the total value of two or more separate banks by consolidating
them into one entity (DeYoung and others).3 Owners of banks that are
less profitable, less efficient, and in weaker condition (in the sense they
are more susceptible to future financial problems) may seek to exit the
industry by selling their businesses, while profitable and efficient banks
may look for opportunities to expand (Hannan and Piloff; Jagtiani;
Wheelock and Wilson).4
In addition to quickly expanding its own business, a bank can fur-
ther increase its business and revenue over time by acquiring another
bank and using its resources to expand loans and other business lines.
These resources may have been underused due to ineffective manage-
ment or insufficient capital. For example, acquiring a bank with excess
ECONOMIC REVIEW • FIRST QUARTER 2015 33

Chart 1
Change in the Number of Community Banks since 2008

Number of banks Number of mergers and failures

7,200 300

6,000 250

4,800 200

3,600 150

2,400 100

1,200 50

2007 2008 2009 2010 2011 2012 2013 2014

Number of Failures (R)

Mergers (R)
banks (L)
Note: Community banks are defined as banks with assets of $1 billion or less.
Source: Federal Reserve change-in-control data.

deposits provides the acquirer with a stable source of funds for expand-
ing lending. Cyree finds that acquirers are willing to pay a larger pre-
mium over book value for a bank with a higher ratio of core deposits
to assets, supporting the idea that banks with high deposit shares are
attractive targets. Acquiring a bank in the same market or with similar
products may allow the acquirer to capitalize on some particular exper-
tise and thereby increase its business with modest expense.5 Acquiring a
bank may also provide the acquirer with a broader client base to which
they can cross-sell additional products and banking services. An acqui-
sition can also boost the merged entity’s revenue by increasing market
share in a given location or business line. Finally, acquiring a bank can
boost revenue growth if the acquired bank is in a market with strong
economic activity.
In addition to potentially increasing revenue, acquiring a bank
can also generate substantial efficiency gains, especially if the acquired
bank is inefficient or has ineffective management. For example, an ac-
quisition can allow banks to spread their costs over a larger asset base,
reduce staff, and eliminate branches. Mergers can be especially ben-
eficial to banks with similar business or geographical profiles as fewer
34 FEDERAL RESERVE BANK OF KANSAS CITY

resources are needed to serve their combined business purpose (Cornett

and others).6
Mergers can also reduce a bank’s risk by diversifying its asset port-
folio, funding sources, and fee generating activities. Acquiring a bank
that operates in different markets or business lines will often increase
diversification. To reduce risk, however, the acquiring bank must have
a strong understanding of the new market’s characteristics and risks,
along with expertise in new business lines. Otherwise, the risk of the
combined institution could increase.7

II. Bank Merger Data

The analysis focuses on voluntary mergers between unaffiliated
banks that occurred between January 1, 2011, and December 31,
2014, in which the acquired banks had assets of $1 billion or less. Ac-
quired banks are grouped according to the year, or cohort, in which a
merger took place, since economic conditions and motives for mergers
may change as a business cycle matures. Characteristics of the different
cohorts can then be analyzed over time.
From 2011 through 2014, the number of voluntary mergers in-
creased each year. Mergers increased from 73 in 2011 to 162 in 2014.
Table 1 divides the total number of banks into those that were acquired
in each year and those that were not. The increase in mergers can be
explained, in part, by an improvement in overall economic and bank-
ing conditions reflecting the transition from the recovery following the
financial crisis to a relatively healthy expansion. Improved economic
conditions make potential targets more attractive due to their healthier
portfolios and the stronger markets in which they operate. Further-
more, improved economic conditions strengthen potential acquirers,
giving them greater ability to acquire new banks.
In addition to the number of mergers, the data include comprehen-
sive measures on bank balance sheets and performance collected from
Call Reports, change-in-control data, and confidential supervisory rat-
ings (see the Appendix for a data description). Call Reports provide
balance sheet and performance information on banks. Federal Reserve
change-in-control data provide information for identifying mergers
and determining whether they are voluntary and between unaffiliated
banks. Confidential ratings data provide information about the safety
and soundness of banks that is not available in Call Reports or other
public data.
ECONOMIC REVIEW • FIRST QUARTER 2015 35

Table 1
Community Banks—Acquired and Non-Acquired
Year Acquired banks Non-acquired banks Total
2011 73 5,881 5,954
2012 116 5,598 5,714
2013 134 5,368 5,502
2014 162 5,117 5,279

Note: See Appendix for a data description.

Source: Federal Reserve change-in-control data.

III. Characteristics of Acquired Banks

Although banks are acquired for different reasons, they often share
similar characteristics relative to banks that are not acquired. Compar-
ing acquired community banks with their non-acquired peers reveals
important differences in profitability, size, and condition. In general,
acquired banks are often smaller, less profitable, less efficient, and in
weaker condition than their non-acquired peers.

Differences in size, profitability, and efficiency

Chart 2 compares the median total assets of acquired and non-
acquired banks from 2011-14. In general, the median acquired bank
is about 15 percent smaller than its peers during the sample period.
Acquired banks are also less profitable. Low profitability reflects lower
returns from loans and other business lines and higher expenses. Panel
A of Chart 3 shows the median return on average assets (ROA), the
broadest measure of profitability, for non-acquired banks and each co-
hort of acquired banks. For each cohort, the chart shows the median
ROA from 2008, the first full year of the crisis, through the year prior
to the merger. For example, the data for the 2011 cohort show the
median ROA for those banks from 2008-10. Panel A shows that ac-
quired banks in every cohort were less profitable than the median non-
acquired bank. In addition, Panel A shows that banks acquired further
past the end of the crisis tended to be more profitable in the year before
they were acquired (the end point of each of the cohort lines), likely due
to the improving economy.
A bank’s ROA can be divided into three components measuring the
bank’s revenue strength and cost structure. These three components are
 36 FEDERAL RESERVE BANK OF KANSAS CITY

Chart 2
Median Total Assets
Dollars, in millions Dollars, in millions
160 160

140 140

120 120

100 100

80 80

60 60

40 40

20 20

2011 2012 2013 2014

Acquired Non-acquired
Notes: Median total assets for each cohort of acquired banks and non-acquired banks are as of the prior year-end.
See Appendix for a data description.
Source: Reports of Condition and Income.

net interest income, which measures the profitability of making loans

and investing in securities relative to the cost of deposits and other li-
abilities; non-interest income, which measures fees earned on non-lend-
ing services and activities; and non-interest expenses, which reflect the
costs of running a bank other than interest paid on liabilities, such as
the costs of personnel and maintaining buildings.
Acquired banks are generally less profitable due to lower levels of
both net interest income and non-interest income, as well as relatively
high operating costs. Panel B of Chart 3 shows the net interest income
of acquired banks was mixed across cohorts relative to non-acquired
banks through 2009. Since the end of the recession, however, all co-
horts of acquired banks had net interest income below the median of
non-acquired banks. In terms of non-interest income, Panel C shows
acquired banks consistently underperformed across all cohorts. Fur-
thermore, acquired banks consistently had higher non-interest expenses
than their peers. Panel D of Chart 3 shows that expenses—including
the costs of personnel, maintaining buildings, and data processing—
were relatively high as a share of average assets.
 ECONOMIC REVIEW • FIRST QUARTER 2015 37

Chart 3
Profitability Measures
Panel A: Median return on assets Panel B: Median net interest income
Percentage of average assets Percentage of average assets Percentage of average assets Percentage of average assets
1.0 1.0 3.7 3.7
0.8 0.8 3.6 3.6
2011 2011
0.6 0.6 2012 3.5 3.5 2012

0.4 0.4 2013 3.4 3.4 2013

0.2 2014 2014

0.2 3.3 3.3
Non- Non-
0.0 0.0 3.2 3.2
acquired acquired
-0.2 -0.2 3.1 3.1
2008 2009 2010 2011 2012 2013 2008 2009 2010 2011 2012 2013

Panel C: Median non-interest income Panel D: Median non-interest expense

Percentage of average assets Percentage of average assets Percentage of average assets Percentage of average assets
0.65 0.65 3.5 3.5

0.60 0.60 2011 3.4 3.4 2011

3.3 3.3 2012
0.55 0.55 2012
3.2 3.2 2013
0.50 0.50 2013
3.1 3.1 2014
2014
0.45 0.45
3.0 3.0 Non-
Non-
0.40 0.40 acquired acquired
2.9 2.9

0.35 0.35 2.8 2.8

2008 2009 2010 2011 2012 2013 2008 2009 2010 2012 2013

Panel E: Median efficiency ratio

Efficiency ratio Efficiency ratio
88 88

84 84 2011

2012
80 80
2013
76 76 2014

Non-
72 72 acquired

68 68
2008 2009 2010 2011 2012 2013

Notes: Medians are as of year-end. See Appendix for a data description.

Source: Reports of Condition and Income.

A final common performance measure is a bank’s efficiency ratio,

defined as non-interest expenses divided by the sum of net interest in-
come and non-interest income. The efficiency ratio increases as costs
rise and income declines. Panel E shows that the median acquired bank
operated less efficiently than the median non-acquired bank across
all cohorts over the sample period. This is not surprising given the
differences in income and expenses between acquired and non-acquired
banks shown in Panels B-D of the chart.

Differences in condition
In addition to being less profitable and less efficient, acquired com-
munity banks also tended to be in weaker condition than non-acquired
38 FEDERAL RESERVE BANK OF KANSAS CITY

banks over the sample period. Acquired banks had relatively less capi-
tal, more problem assets, and lower regulatory ratings. Their weaker
condition is consistent with their lower profitability and efficiency,
since factors such as problem loans reduce interest income and lead to
higher costs as banks work them out.
A bank’s condition can be measured in many ways, but capital tends
to be the first measure analysts examine. In many cases, losses resulting
from the crisis left banks with less capital available to cover unexpected
losses, making it more difficult for these banks to make new loans.
Panel A of Chart 4 shows that at the time of their acquisition, acquired
banks were generally less well-capitalized than non-acquired banks,
based on the ratio of tangible common equity to tangible assets. The
pattern is less pronounced or absent for banks acquired in 2012 and
2013, consistent with a gradual healing of the industry: the first banks
to fail or be acquired were in the worst condition, and the remaining
banks generally increased their capital ratios after the recession.
Two other common measures of a bank’s condition are the quality
of its asset portfolio, as measured by the share of noncurrent loans to
net loans (Chart 4, Panel B), and the share of other real estate owned
(OREO) to total assets (Chart 4, Panel C). Noncurrent loans are loans
more than 90 days overdue or not accruing interest. The share of non-
current loans thus provides a good measure of a loan portfolio’s risk of
default. High levels of OREO reflect past lending that ended in the
borrower defaulting and the bank taking possession of the real estate
used to collateralize the loan. As Panels B and C of Chart 4 show, both
of these metrics increased for all banks during and after the crisis. The
rise in these measures for acquired banks relative to non-acquired banks
was substantial, suggesting that acquired banks invested in relatively
riskier loans prior to the crisis.
A final measure of a bank’s condition is the confidential supervisory
risk rating (CAMELS) that the state and federal supervisory agencies
use to summarize a bank’s condition after an examination. The CAM-
ELS rating is an aggregate measure on a scale of 1 (best) to 5 (worst),
based on capital adequacy (C), asset quality (A), management qual-
ity (M), earnings (E), liquidity (L), and sensitivity to market risk (S).
Chart 4, Panel D shows the mean ratings for acquired banks have been
substantially worse than the industry average since the crisis, with the
gap for 2014 mergers even wider than in 2008.8
 ECONOMIC REVIEW • FIRST QUARTER 2015 39

Chart 4
Condition Measures
Panel A: Median tangible common equity Panel B: Median noncurrent loans
Percentage of tangible assets Percentage of tangible assets Percentage of net loans Percentage of net loans
10.5 10.5 3.0 3.0

10.0 10.0 2.5 2.5

9.5 9.5 2.0 2.0

9.0 9.0 1.5 1.5

8.5 8.5 1.0 1.0

8.0 8.0 0.5 0.5

2008 2009 2010 2011 2012 2013 2008 2009 2010 2011 2012 2013
2011 2013 Non- 2011 2013 Non-
2012 acquired acquired
2014 2012 2014

Panel C: Median other real estate owned Panel D: Mean CAMELS composite
Percentage of total assets Percentage of total assets Composite Composite
3.5 3.5
0.8 0.8
0.7 0.7
3.0 3.0
0.6 0.6
0.5 0.5 2.5 2.5
0.4 0.4
0.3 0.3 2.0 2.0
0.2 0.2
1.5 1.5
0.1 0.1
0.0 0.0 1.0 1.0
2008 2009 2010 2011 2012 2013 2008 2009 2010 2011 2012 2013
2011 2013 Non- 2011 2013 Non-
2012 acquired 2012 acquired
2014 2014

Notes: Medians/means are as of year-end. In Panel A, tangible common equity is total equity less perpetual pre-
ferred stock, goodwill, and other intangible assets. Tangible assets are total assets less goodwill and other intangible
assets. In Panel B, noncurrent loans is the sum of loans 90 or more days past due and nonaccrual loans. See Ap-
pendix for a data description.
Source: Reports of Condition and Income.

Differences in balance sheet composition

Differences in a bank’s profitability and expenses reflect differences
in the composition of its balance sheet, such as the share of loans, cash,
and deposits held as a percentage of its total balance sheet. Panel A of
Chart 5 shows acquired banks tended to have loan shares modestly
higher than non-acquired banks until 2012. The 2013 cohort, which
had significantly lower loan shares, is an exception to this trend. Pan-
el B shows acquired banks had higher cash shares than non-acquired
banks, and that the gap increased over time. On the liability side,
Panel C shows acquired banks tended to have modestly higher deposit
shares than non-acquired banks, particularly in the year prior to their
 40 FEDERAL RESERVE BANK OF KANSAS CITY

Chart 5
Balance Sheet Measures
Panel A: Median net loans Panel B: Median cash
Percentage of total assets Percentage of total assets Percentage of total assets Percentage of total assets
75 75 16 16
14 14
70 70
12 12
65 65 10 10

60 60 8 8
6 6
55 55
4 4
50 50 2 2
2008 2009 2010 2011 2012 2013 2008 2009 2010 2011 2012 2013
2011 2013 2011 2013
Non-acquired Non-acquired
2012 2014 2012 2014

Panel C: Median deposits

Percentage of liabilities Percentage of liabilities
100 100
99 99
98 98
97 97
96 96
95 95
94 94
93 93
92 92
2008 2009 2010 2011 2012 2013

2011 2013
Non-acquired
2012 2014

Notes: Medians are as of year-end. See Appendix for a data description.

Source: Reports of Condition and Income.

acquisition. These results suggest that acquiring banks may have tar-
geted banks that would provide quick increases in loans and access to
cash and deposits to support future loan growth. Cyree finds that ac-
quirers are willing to pay a larger premium over book value for a bank
with higher deposits to assets, supporting the idea that banks with high
deposit shares are attractive targets.9 These motives are perhaps unsur-
prising given the lack of lending opportunities and loan demand during
much of the recovery from the financial crisis.
ECONOMIC REVIEW • FIRST QUARTER 2015 41

IV. The Relative Importance of the Characteristics of

Acquired Banks
Although acquired community banks share many characteristics,
the statistical or economic significance of these characteristics in deter-
mining which banks are acquired can differ. To rank the importance of
the characteristics of banks most likely to be acquired, two analytical
methods are used: classification trees and probit regression.
Classification trees, as the name suggests, classify data in succes-
sive steps according to various criteria, resulting in smaller groups as
the analysis progresses. The objective is to create separate groups with
similar characteristics, in this case, groups of banks that are likely to be
acquired or not.
Splitting banks into groups requires identifying an appropriate vari-
able on which to split, as well as the value used to separate the sam-
ple. The ideal variable and split value would result in two samples, or
branches of the tree: one containing all acquired banks and the other
containing all non-acquired banks. In practice, however, such a clean
split is unlikely.
As an example, Figure 1 shows a classification tree based on banks
that were acquired in 2014. The sample used to construct the tree
comprises 675 banks, 123 of which were acquired. The tree shows that
banks with an ROA below 61 basis points were more likely to be ac-
quired. About 31 percent of banks with an ROA below this threshold
were acquired, compared to about 11 percent of banks with an ROA
above the threshold. It is perhaps not surprising that ROA is the first of
the 24 variables to split the sample between acquired and non-acquired
banks, given that Chart 3, Panel A showed ROA tends to distinguish
acquired banks from other banks.10
The tree also shows that among the subset of banks with a higher
ROA, those that are relatively inefficient are more likely to be acquired.
Among the 426 banks with an ROA greater than 61 basis points, only
seven were relatively inefficient with efficiency ratios above 90. It is not
surprising that so few banks with relatively high profits would be rela-
tively inefficient. However, four of these seven banks were acquired.
The example in Figure 1 is based on an actual subset of bank merg-
ers occurring in 2014. In general, the vast majority of banks are not
acquired. For example, only 3 percent of all the banks in the data set
42 FEDERAL RESERVE BANK OF KANSAS CITY

Figure 1
Classification Tree for Bank Mergers in 2014

Initial sample
Non-acquired 552 123 Acquired
(82%) (18%)

ROA ≥ 61bp ROA < 61bp

380 46 122 77
(89%) (11%) (69%) (31%)

Efficiency ratio < 90 Efficiency ratio ≥ 90

(Relatively efficient) (Relatively inefficient)

377 42 3 4
(90%) (10%) (43%) (57%)

in 2014 were acquired. With such a low number of acquisitions, the

classification tree analysis produces subsamples that primarily contain
non-acquired banks simply because they dominate the data set. As a
result, the criteria used to evaluate the subsets finds they are not suf-
ficiently different, and the classification tree algorithm does not create
additional branches of the tree.
Random sampling can address this issue by better balancing the
number of observations between acquired and non-acquired banks. In
this procedure, the sample includes all acquired banks and a random
sample of non-acquired banks to create a 5:1 ratio of non-acquired to
acquired banks. Although this ratio is much higher than what is ob-
served in the data, it allows the classification algorithm to more sharply
compare the characteristics of the acquired banks with those that were
not acquired.
One issue with sampling the data is that the results may depend on
the particular random subset of data selected. To mitigate this potential
bias, 1,000 different subsamples are constructed for each cohort. The
classification tree analysis is then run on each subsample, generating
ECONOMIC REVIEW • FIRST QUARTER 2015 43

1,000 different trees. For each year of the sample, ROA and efficiency
are identified as the most important variables in distinguishing acquired
from non-acquired banks, suggesting that relatively unprofitable and
inefficient banks are the most likely to be acquired. The average cutoff
values for ROA are 10, 51, 49, and 46 basis points for banks acquired
in 2011, 2012, 2013, and 2014, respectively. The corresponding cutoffs
for efficiency ratios are 90, 95, 86, and 85. As an example of how these
results are interpreted, in 2014, banks with ROA less than 46 basis
points were more likely to be acquired, while banks with ROA equal to
or greater than 46 basis points were more likely to be acquired if their
efficiency ratio was equal to or greater than 85.
To understand the statistical and economic significance of the most
important variables identified by the classification tree analysis, ROA
and the efficiency ratio are used as independent variables in a probit re-
gression.11 The dependent variable indicates whether a bank is acquired.
Table 2 shows the results for each cohort using observations for all com-
munity banks. The coefficient on ROA is significant at the 5-percent
level for every year in the sample. The negative coefficient indicates that
as ROA increases, the probability of being acquired declines. The coef-
ficient on the efficiency ratio is positive as expected in every year except
2014, but it is not significant in explaining whether a bank is acquired
in any year. The insignificance of the efficiency ratio may reflect that it is
important for only a small number of acquisitions when simultaneously
accounting for the effect of ROA, which was shown to be the dominant
variable in the classification tree analysis.
To get a sense of the importance ROA has for a bank’s probability of
being acquired, Chart 6 shows how the estimated probabilities vary by
cohort.12 For banks with a high level of losses—for example, an ROA of
-500 basis points—the probability of being acquired in 2014 was 0.48,
substantially higher than the 0.07 probability in 2012 for a bank with
the same ROA. As ROA increases and turns positive, however, the prob-
ability of being acquired falls to near zero regardless of the year.
The probability of a bank with a negative ROA being acquired is
generally economically significant. For example, the estimated prob-
abilities of being acquired in 2014 for banks with ROAs less than 100
basis points are significantly greater than the 0.03 probability of being
acquired calculated from the raw data sample.
44 FEDERAL RESERVE BANK OF KANSAS CITY

Table 2
Probit Regression of Acquired Banks
Year ROA Efficiency Number of observations
2011 -0.14** 0.0004 5,954
(0.026) (0.001)
2012 -0.12** 0.0006 5,714
(0.035) (0.001)
2013 -0.23** 0.0003 5,502
(0.040) (0.009)
2014 -0.32** -0.0003 5,279
(0.047) (0.001)

** Significant at the 5-percent level.

Notes: Dependent variable is whether a bank is acquired. Standard errors in parentheses.
Source: Reports of Condition and Income.

Chart 6
Probability of Being Acquired Due to Changes in ROA by Cohort
0.6 Probability of being acquired
2014
0.5

0.4

0.3
2013

0.2

0.1
2012

-6 -4 -2 0 2 4 6
ROA
Notes: Probabilities derived from the probit regression results in Table 2. In calculating the probabilities, the
coefficient on efficiency is set to zero because it is insignificant.
ECONOMIC REVIEW • FIRST QUARTER 2015 45

These results suggest that for a given ROA, the probability of be-
ing acquired increases as the effects of the financial crisis and recession
recede. Improving economic and banking conditions have generally
made banks stronger and more optimistic about the future of the econ-
omy. As a result, banks are looking for opportunities to grow and pos-
sibly expand into new markets and activities, which may explain why the
number of mergers has increased.

V. Conclusion
The number of banks has declined sharply over the past 30 years,
due in part to voluntary mergers between unaffiliated banks. In fact,
voluntary mergers have been the primary factor in the decline since
the end of the 2007-09 recession. This article analyzes the mergers of
community banks over the past four years and finds they are consistent
with the goals of achieving greater economies of scale and improving
efficiencies. Acquired banks tend to be smaller and have a lower return
on assets, lower net interest income, and higher non-interest expenses
than non-acquired banks. Acquired banks may be less profitable be-
cause they tend to have lower loan and higher cash and deposit shares.
In addition, the condition of acquired banks tends to be worse than
their industry peers in terms of capital, supervisory examination rat-
ings, and problem loans and assets. Among the characteristics that dif-
ferentiate acquired banks, statistical analysis suggests profitability and
efficiency are the most important factors.
The results suggest that mergers on average result in more efficient
banks and a sounder banking system, which should lead to greater ac-
cess to credit at lower cost and thus be beneficial for local communities.
However, the benefits of mergers can be offset if mergers make local
banking markets less competitive and reduce the communities’ access
to banking services and credit. Although federal banking regulatory
agencies monitor mergers and do not approve those that are expected
to result in uncompetitive banking markets, more research is needed to
determine the net effect of bank mergers on local communities.
46 FEDERAL RESERVE BANK OF KANSAS CITY

Appendix
Data Description
The article focuses on unaffiliated bank mergers that occurred be-
tween 2011 and 2014 involving acquisitions of community banks,
defined as banks with assets of $1 billion or less. The data consist of
25 variables from Call Reports, the Federal Reserve System’s database
of changes in bank control, and confidential supervisory examination
ratings. To eliminate outliers, banks with ROA greater than the 99.5
percentile or less than the 0.5 percentile are excluded from the analysis.
For mergers that involve bank holding companies (BHCs), unaf-
filiated bank mergers are defined as acquisitions that occur between
banks not part of the same bank holding company (BHC). When
BHCs merge, however, the banks are often not simultaneously merged.
BHCs may delay bank mergers, for example, to determine the best
way to consolidate operations and information technology systems or
make personnel changes. For such mergers, the merger of the subsidiary
banks is considered unaffiliated if it occurs within one year of the BHC
merger. The one-year cutoff was chosen to ensure that banks merged in
such a manner are not improperly classified as consolidations of banks
part of the same BHC. The distinction between unaffiliated mergers
and consolidations is important because the reasons driving these two
events very likely differ. Including consolidations with unaffiliated
mergers in the analysis could bias the results.
ECONOMIC REVIEW • FIRST QUARTER 2015 47

Endnotes
1
Other factors affect the change in the number of banks from year to year,
the most important of which is newly chartered banks (referred to as de novo
banks). Other than the crisis periods of the late 1980s, early 1990s, and 2007-09,
the decline in the number of banks is almost entirely due to mergers of affiliated
or unaffiliated banks, partially offset by de novo banks. For example, from 1995
to 2007, about 5,200 mergers were partially offset by about 2,000 de novos and
only 47 bank failures.
2
These numbers include mergers of affiliated and unaffiliated banks because
both types of mergers reduce the number of banks. However, mergers of affiliated
banks have declined sharply in recent years because most geographic restrictions
were eliminated by the mid-1990s. As a result, the vast majority of mergers are
between unaffiliated banks.
3
DeYoung and others provide an extensive review of the merger and acquisi-
tion literature. In addition to business motives for mergers, private motives can
also play an important role in a banker’s decision to sell. For example, community
banks are often family-owned and may lack successors or be located in declining
rural markets that can become “overbanked.” Alternatively, some owners start
banks with the goal of quickly selling them to a larger institution, rather than
operating them independently on a long-term basis. Although this latter example
may sound like a business motive, it is primarily driven by the owner’s private
motive to cash out as quickly as possible.
4
Hannan and Piloff show that banks are more likely to be acquired as their
profitability declines and their inefficiency rises. Jagtiani shows acquirers tended
to be more efficient and better managed than the targets. Wheelock and Wilson
also find that increased inefficiency or decreased profitability lead to a greater
probability of being acquired.
5
For relatively small community banks, specializing in a business activity or
location may allow them to diversify the idiosyncratic risk in their loan portfolios
by reducing exposure to individual loans.
6
Cornett and others show significant increases in earnings in acquiring banks
following a merger, particularly when mergers result in focusing activities or geo-
graphical reach, as opposed to diversifying.
7
During the crisis, many community banks failed because they had expanded
lending into out-of-territory areas where they had little understanding of the mar-
kets and associated risks. Since the crisis, one of the risks that has become more
prevalent is strategic risk, which includes the risk of banks expanding into new
business lines without sufficient expertise.
8
A CAMELS rating of 3 means a bank’s condition is less than satisfactory.
The mean is used instead of the median because the discrete nature of the rating
system leads to all of the medians being 2, which is not surprising since a 2 rating
is near the middle of the range and not less than satisfactory.
48 FEDERAL RESERVE BANK OF KANSAS CITY

9
While Cyree’s analysis uses core deposits, the trend for core deposits and
total deposits is similar for our sample over the period analyzed.
10
The full data set described in the Appendix has 25 variables. However, the
data set used to conduct the classification tree analysis excludes the CAMELS rat-
ing and thus has only 24 variables. The CAMELS rating was excluded because,
as a supervisory measure of a bank’s overall condition, it reflects many of a bank’s
underlying characteristics, such as its balance sheet and condition variables. As
a result, if the classification tree were to split on the CAMELS rating, especially
at the first level, it would mask the underlying differences between acquired and
non-acquired banks.
11
Probit regression is a regression technique used when the dependent vari-
able is a discrete “yes or no” variable, such as whether a bank is acquired or not, as
opposed to a continuous variable.
12
In Chart 6, the coefficient on efficiency is set to zero because it was insig-
nificant. Alternatively, setting efficiency to the sample average for each cohort and
using the estimated coefficients does not materially change the results.
ECONOMIC REVIEW • FIRST QUARTER 2015 49

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